“Conventional wisdom has, until very recently, suggested that DB pensions come with a cast iron guarantee. They don’t, but neither do we have a systematic risk issue across the whole of the UK DB universe. Our analysis of FTSE350 schemes shows that the majority of companies are well placed to support schemes and pay benefits in full. But we’d agree that running DB schemes has become more challenging and costly for a whole host of reasons.
“One of the biggest issues is the amount of unnecessary risk being run in schemes - to the tune of over £400bn p.a. That is, in the bad outcomes, UK DB deficits will grow by £400bn over a period of just 12 months. This reflects relatively low levels of interest rate, inflation and longevity protection in place. This puts strain on employers’ ability to meet pension obligations and could take a weak sponsor to the brink. And if they go over the edge and members are caught by the pensions lifeboat, they will each lose £50,000 of their benefits on average. Schemes need to manage risks through a longer term lens. They need to move away from solely focussing on deficits and discount rates which can encourage an unnecessary rush to full funding and often leads to greater cash calls on sponsors. Instead they should focus on resilience to risk. This is about the efficient use of capital to tackle excess risk as a top priority. Once this is under control, there should be a laser focus on managing costs. As a strategy, simply pouring more money into DB pensions hasn’t worked for the last 15 years, so it is fair to assume it won’t over the next 15.”
Commenting on the proposals to make it easier to standardize and simplify benefits: “The PLSA’s proposals for simplifying benefits should be welcomed. Member outcomes could be improved in scheme specific circumstances if we see these proposals take shape. Specifically it will make it easier and less costly to get economies of scale either by transferring risks to an insurer or to some emerging super fund consolidator.
“While there will be significant upfront resource and cost to do this, ultimately it will be for the greater DB member good. In time it should lead to a reduction in costs and take some sponsors away from the brink. But inevitably there will be winners and losers amongst individual scheme members. We need to recognise this and take care to simplify benefits in a way that doesn’t create significant outliers. And we agree that this process needs to be done with full agreement from the trustees to ensure it’s in the scheme members’ best interests on a case by case basis.”
Discussing the proposals to create a DB Chair Statement he added: “Chair statements are well established in the DC world, and it’s behaviourally positive to formally capture why a scheme is governed in a particular way. It should encourage a comparison of the relative benefits of the status quo versus alternative pension delivery mechanisms should they emerge, such as super fund consolidators. This should be welcomed by the DB community.”
Commenting on the consolidation proposals, he said: “For employers with shaky covenants that are less likely to be able to pay benefits in full, being able to transfer to a consolidated vehicle with an immediate capital injection from third party investors, with appropriate regulatory protection, could clearly improve outcomes for members. Each scheme would need to undertake its own analysis to determine whether this is the right route for them - for example in light of their sponsor covenant, funding health and scale benefits on offer. But for smaller schemes with stressed sponsors, being able to take advantage of economies of scale to reduce costs, broaden investment options and improve governance, this should be a welcome avenue to better outcomes for members. It’s now over to the industry to innovate sustainable superfund solutions.”
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